Must-know: An overview of the iron ore industry

Must-know: The financial gains in iron ore companies

By Annie Gilroy
•
Jul 16, 2014 4:55 pm EDT

Financial gains in iron ore companies

The volume a company is going to produce in a particular year is a function of its reserves at any given time. The reserve is the economically mineable material derived from measured or indicated mineral resource—concentration or occurrence of material. So, for a particular company that has reached the production stage, the volume number is more or less predictable. After this, the company can either enter into take-off agreements where the buyer would buy a certain amount of goods at a predetermined price or it can go for the spot price.

With the emergence of China’s demand, prices moved to quarterly contracts from annual private negotiations in 2010. Later they moved to monthly contracts. A much higher tonage is now agreed at spot rates. Currently, the benchmark used for iron ore prices is 62% of the Cost and Freight (or CFR) of China’s Tianjin port prices, which is currently around $97–$100 per ton.

For example, Vale’s (VALE) CFR would be much higher than Rio Tinto (RIO) or BHP Billiton (BHP), since shipping costs from Brazil to China are much higher as compared to shipping costs from Australia. Cliffs Natural Resources (CLF) would get a discount for lower grades and higher impurities. These companies form close to 18% of the iShares S&P Global Materials Sector Index Fund (MXI).

Costs

The second most important factor in determining the cash generating ability of the company is its cost base. There are various costs that a mining company has to incur. The costs include:

Operating costs – This is the cost incurred by the company to dig the ore out of the mine. It’s also the cost of preparing it to be exported like labor costs, energy, power, water, exploration and evaluation costs, and refining costs.

Capital expenditure (or capex) – It includes the development or start-up, and maintenance capex, which is an on-going cost of replacing worn out equipment.

Royalties – It’s the usage based payment made by the user to the owner of the asset for the right of its ongoing use.

Apart from these, other costs include payments that are common for any other company like interest charges for use of credit and tax payments at country’s stipulated tax rate.

In conclusion, a mining company would make money by selling its production at the prevailing or pre-agreed price to the buyer after paying for all the costs directly related to production or incidental to it.

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